Dow drops more than 1,000 points as volatility grips markets

Morning commuters pass the New York Stock Exchange on Wednesday. REUTERS/Brendan McDermid

U.S. stocks gave up even more ground Thursday, as volatility kept the markets in its grip.

The Dow Jones industrial average tipped 1,033 points into the red, down 4.2 percent, to close at 23,860 as fears deepened over rising interest rates. Its steep dive in the final minutes of trading put the Dow in correction territory.

The technology-laden Nasdaq and the broad Standard & Poor's 500-stock index also drifted lower during the day – and each was down more than 3 percent. Trading volumes were 50 percent above normal.

The pullback Thursday across U.S. indexes is something that did not happen in all of 2017. And the 2018 gains for the Dow and S&P have been wiped out.

Many are bracing for more wild swings ahead as the Cboe Volatility index is holding at twice its level from a week ago.

It's the fourth ugly day in global markets. European stocks saw across-the-board losses, led by the Germany's blue-chip DAX, which lost 2.6 percent, or 330 points. Most Asia indexes were positive overnight.

All major sectors were down Thursday, with real estate and financials leading the plunge, signaling investor unease around interest rates and the prospect of higher inflation.

Alexandra Coupe, associate director investment manager PAAMCO, said rising inflation makes stocks less attractive. Stocks over the long term create more wealth than fixed-income bonds, but they are more volatile and have more risk.

"If I have to choose bonds or equities, with interest rates going up, bonds just got more attractive," she said.

Coupe said the volatility is coming about because investors are having difficulty deciding between stocks and bonds at the moment. There are risks from moving wholesale from stocks to bonds.

"You don't want to move too much too soon," Coupe said. "You don't want to be caught in fixed income as rates are moving up. That's why everybody is going back and forth. We haven't had inflation, and now we have it and everyone freaks out. Be careful what you wish for."

The yield on the U.S. 10-year Treasury bond touched a four-year high before falling back to 2.83 percent. A 3 percent yield is looked upon by investors as a motive for people to flee the risk of stocks for the relative safety of bonds. When bond prices go lower, their yield increases.

"There is a lot of concern in the rising yield in the 10-year Tressury note," said David Kass, professor of finance at the University of Maryland. "As it approaches 3 percent, concerns about inflation and competition for stocks by fixed income securities are increasing."

Some believe the 3 percent yield is inevitable. Bond yields are rising as the Federal Reserve trims its U.S. bond holdings. The Treasury is also having to borrow more money, partly because of the tax cuts, and issuing more debt tends to raise yields.

Thursday's fluctuations came despite good economic news. Social-media company Twitter posted its first profit, and Yum Brands, Cardinal Health and Tyson Foods also exceeded earnings expectations. Nearly 80 percent of companies that have reported so far this earnings season have suprised analysts to the upside.

Some say the fluctuations are because of the good news, with fears that an overheated economy and nascent inflation will push the Federal Reserve to raise rates. The latest inflation figures are anemic at 1.7 percent.

"Investors are nervous about three things," said Larry Hatheway, an economist and Zurich-based asset manager. "There is an emerging inflation story in the U.S. – and rising U.S. inflation makes monetary policy less predictable. Accelerating inflation may crimp corporate profits. And the Fed may hesitate to come to the rescue. They won't be able to provide that nice predictability and certainty that they provided ever since they started the rate hikes a few years ago."

LPL Research released a report titled "Volatility is Back," which pointed to fear of rising interest rates as the source of the recent swings but cautioned that the economy is fundamentally strong.

"The primary culprit was higher-than-expected wage growth in the January jobs report, which may have increased fears that the Federal Reserve would be more aggressive with interest rate hikes in 2018," according to LPL. "However, the selling pressure unmasked a variety of issues, including investor complacency and the difficulty of unwinding crowded and complex trades involving leverage, or borrowed money."

"Though never any fun to endure," it said, "pullbacks are a normal course for long-term investing."

Thursday's markets reflected the recent craziness in stocks. The Dow moved nearly 500 points during trading Wednesday before closing down 19 points, or 0.08 percent, at 24,893. Standard & Poor's 500 index and the Nasdaq also finished down Wednesday.